Seeking Alpha
Long/short equity, deep value, special situations
Profile| Send Message|
( followers)  

The Apple (NASDAQ:AAPL)-laden Nasdaq-100 (QQQ) trounced the S&P 500 (SPY). While both indexes include Apple in the portfolio, the 100 is far heftier with 19.5% Apple, the 500 only 4%. The giant Apple holdings of the Nasdaq-100 had their effect: The index clobbered the S&P 500, gaining a healthy 18% versus the S&P's shabbier 5% year performance.

(click to enlarge)

(1 Year Chart)

Ironically, Nasdaq OMX has been trying to make its Nasdaq-100 more evenly balanced, less dependent on one stock (even if it is Apple) and more reflective of its top 100 companies. The dominance of Apple in the index wasn't intentional. In fact, it's something the Nasdaq dislikes.

The first anniversary of the Nasdaq 100 epic rebalancing

A year ago, Nasdaq OMX decided its Nasdaq-100 index was overweight Apple. At the time, 20.5% of the index was Apple. Rebalancing the index, Nasdaq chopped over 8% of its Apple shares, jettisoning over 6 million shares of the iProduct company and replacing them with millions of shares of Oracle (ORCL), Intel (INTC), Google (GOOG), and Yahoo (YHOO). It was an unusual event: The Nasdaq-100 had been "rebalanced" only once before (1998) in its 26 year history.

History repeats itself

Ironically, a year later, the Nasdaq OMX is faced with the same dilemma: As Apple shares have increased in value, the company once again represents almost 20% of the index. It would be a shock if Nasdaq OMX isn't having discussions right now about reducing Nasdaq-100's Apple position. After all, they cut the index's Apple share a year ago upon reaching that 20% mark.

The price of diversification: A cautionary tale

Personally, I'd rather have more than less Apple in my portfolio. This is one stock you don't want to "rebalance." Sometimes, chucking your best performing stock isn't such a good idea. Imagine how much better the QQQ would have performed if Nasdaq OMX hadn't rebalanced the index!

Using some back of the envelope math: Last April, Apple represented 20.5% of the QQQ. The QQQ was priced at $58.50, making its Apple position worth $11.99. Apple has risen 83% since then. If the index had held onto all of its Apple shares, that $11.99 position would now be $21.94.

Instead, QQQ cut its Apple to 12.3%, representing about $7.21. Now, having reached 19.5% of the QQQ, Apple is worth $13.90 of the index price. Had the QQQ kept all of its Apple shares, it would have been $8 higher, trading at $75.72, a much nicer 29% climb.

What will Nasdaq OMX do?

Judging by last year's "Special Rebalance," the Nasdaq OMX should follow its same reasoning and send the QQQ dumping 40 percent of its Apple position once again. I'm sure there are elements at Nasdaq that want to bask in their index's glory. (Who wouldn't want to belong to a club of stocks like Apple? Witness Facebook's decision to join the Nasdaq.) In the end, it's an index of 100 stocks, not just one. The Nasdaq will reweight the Nasdaq-100 and soon.

How will a rebalancing affect Apple?

Apple is one of most liquid stocks around: 25 million shares on average trade each day. The passive dump will get sopped up easily, much as occurred the last time Nasdaq-100 rebalanced. The only victim of such a rebalance? Why, the QQQ, of course: less Apple; less juice. Those holding the ETF might rethink: With a smaller Apple position, the juice behind QQQ's run will be watered down.

Source: Will The Nasdaq-100 Water Down Its Apple Juice?